Disciplinary Sanctions Held Nondischargeable Even Though Not Paid to the State

Discovery sanctions to be paid as part of state bar disciplinary proceedings are nondischargeable under Section 523(a)(7), even though the debtor-attorney was directed to pay the sanctions to the adversary, according to the Ninth Circuit Bankruptcy Appellate Panel.

The BAP also ruled that costs incurred by the state bar are similarly nondischargeable.

The California Supreme Court upheld an attorney’s 30-day suspension from practice. As conditions to the reinstatement of her license, the state high court required the lawyer to pay the state bar association about $19,000 of costs incurred in the disciplinary proceedings and to pay an adversary about $6,000 in unpaid discovery sanctions.

The lawyer filed a chapter 13 petition that was converted to chapter 7. She commenced an adversary proceeding against the state bar, seeking reinstatement of her license and a declaration that the monetary sanctions were dischargeable under Section 523(a)(7).

The statute provides that a debt is nondischargeable “to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss . . . .” [Emphasis added.]

The bankruptcy court dismissed the debtor’s suit on the bar association’s motion to dismiss. In a nonprecedential opinion, the BAP affirmed on April 11. The panel consisted of Bankruptcy Judges William Lafferty, Gary Spraker and Robert J. Faris.

The appeal turned on inferences the BAP took from Kelly v. Robinson, 479 U.S. 36 (1986).

The BAP characterized the Supreme Court as holding in Kelly that criminal restitution was nondischargeable under Section 523(a)(7) even though it was payable to the victim of the crime, because (1) the victim had no control over the decision to award restitution or the amount of the award, and (2) the decision to impose restitution turned on the penal goals of the state, not the victim’s injuries.

In a footnote, the BAP said that “Kelly seems to have been expanded to the point where the requirement that the fine or penalty must be payable ‘to and for the benefit of a governmental unit’ has been read out of the statute.” However, the appellate panel noted that Congress amended the Bankruptcy Code 33 times after Kelly but never legislatively overruled the Supreme Court’s interpretation of Section 523(a)(7).

The BAP said it understood Kelly to mean that “the ultimate payee of the restitution is not determinative of dischargeability” when “the purpose of the restitution is to further a governmental interest in rehabilitation and punishment.” Therefore, the BAP said, nondischargeability turns “on the punitive nature of the fine or penalty at issue.”

With regard to the payment of the bar association’s costs, the BAP noted that the California legislature had amended the disciplinary statute to provide that the costs imposed on an attorney are “penalties” imposed “to promote rehabilitation and to protect the public.”

With little difficulty, the BAP held that costs payable to the bar association as a condition to reinstatement are nondischargeable.

Next, the BAP acknowledged that California courts have held that discovery sanctions are not punitive. Still, the BAP interpreted “Kelly and its progeny” to mean that discovery sanctions were “transformed into a primarily punitive sanction” when they were “ordered to be paid by the [California] supreme court as part of a disciplinary proceeding.”

Even though the debtor-lawyer was to pay discovery sanctions to her adversary as a condition to reinstatement of her license, the BAP held that the award was “punitive and rehabilitative” and therefore nondischargeable.

Click here to read ABI’s report on a 2016 Ninth Circuit opinion that was similarly critical of Kelly.